San Diego will use $80 million in emergency funds due to revenue losses.

City savings goal was on track, now it will drop to 10% of operating budget

Plummeting tax revenue during the COVID-19 pandemic will force San Diego to make deep budget cuts and burn through more than $80 million in emergency reserves, a move that could damage the city’s credit rating.

The proposed budget Mayor Kevin Faulconer unveiled three weeks ago recommends using $54 million of the city’s $205 million emergency reserve to cover part of the roughly $350 million in recent revenue shortfalls — primarily lost hotel tax and sales tax.

Faulconer also proposes canceling a $12.8 million reserve contribution scheduled for June and a $13.6 million reserve contribution scheduled for June 2021.

In recent years, San Diego has been steadily increasing its emergency reserves with the goal of meeting an accounting best practice of having set aside the equivalent of at least two months of expenses, or 16.7 percent of the city’s annual operating budget of $1.5 billion.

Before the pandemic, San Diego was on track to increase its emergency reserve fund to 15.75 percent of its operating budget in June 2021 and to meet the ultimate goal of 16.7 percent by 2025.

But the mayor’s recent budget would shrink the emergency reserve account to 10.25 percent of the operating budget, or $138.8 million — $74.6 million below the $213.4 million there would be if the city wasn’t planning to use any reserves.

And Faulconer plans to announce May 19 even deeper budget cuts and a potentially more aggressive use of reserves. The proposed budget that uses $80 million in reserves was created before major events like Comic-con were canceled.

City Council members, including Chris Ward and Chris Cate, have expressed concerns about how the depletion of reserves could negatively affect the city’s credit rating, which could increase the interest rate on city bonds.

Jeff Kawar, a deputy director in the city’s Independent Budget Analyst’s office, said he doesn’t expect San Diego to lose its relatively high double-a rating immediately.

“My understanding is that there might be a small change to a ‘negative outlook,’ but no significant downgrade is expected just yet,” Kawar told the council during a Monday public hearing.

A negative outlook means that a rating may be lowered, while a stable outlook means that a rating is not likely to change, according to Standard & Poor’s, one of the three key rating agencies in the U.S.

Kawar noted that any change to the city’s rating would come at a time when many government agencies are facing similar revenue shortfalls.

But the pandemic has had the most significant effect on tourism and hotel taxes, which San Diego relies on more than most other cities.

Rolando Charvel, the city’s chief financial officer, said San Diego would be more vulnerable to a credit downgrade if the city wasn’t proposing sweeping budget cuts along with the use of reserves.

Charvel said city finance officials have been seeking guidance from the rating agencies since the pandemic began.

“They understand that reserves are there for a reason,” he said. “Basically, what they’re looking for is for us to take a balanced approach in addressing the revenue shortfall.”

Councilman Ward expressed concerns that San Diego may be burning through its reserves too quickly, especially if the pandemic sparks a long-lasting economic recession.

“We definitely can’t use all of it, because this could be multiyear in nature,” Ward said.

Kawar said the Government Finance Officers Association, which created the 16.7 percent goal for emergency reserves, has not established guidelines for how quickly cities could or should reduce their reserves in cases of emergency.

Faulconer also proposes using a separate “pension stabilization” reserve of $12.2 million to help balance the budget. That reserve now has $7.9 million and was due to receive another $4.3 million next year. City officials say that $249 million in federal COVID-19 relief they recently received could help replenish the reserves, but there are still questions about what expenses that money can cover. In addition to using reserves, Faulconer’s budget proposes deep cuts to libraries, parks, pools, arts funding and many other city services. A final budget is scheduled for council adoption June 8.

david.garrick@sduniontribune.com